ABSTRACT
This chapter explores how asymmetric information—when one party in a transaction knows more than the other—leads to market failures through adverse selection and moral hazard. We introduce foundational concepts and real-world applications, including insurance markets, credit markets, ethical production, and personal services. The classic “market for lemons” illustrates how hidden information reduces trade and can collapse markets. Moral hazard arises when hidden actions distort incentives, as in sharecropping, financial regulation, and procurement. We analyze tools to mitigate these problems: mandatory insurance, signaling, screening, contract design, and repeated interaction. Institutions, legal standards, branding, and social norms all help restore market functioning. Applications span labor markets, financial crises, environmental risk, corporate governance, and public-private service provision. The chapter concludes with reflections on honesty, trust, and how institutions shape economic behavior in settings of asymmetric information.
